The IRS Is Looking to Recharacterize Related Party Debt as Equity Simply for Failing to Meet on a Timely Basis New Contemporaneous Written Documentation Requirements

In the early 1980’s, the IRS issued regulations on the question of when loans to corporations would be recharacterized under Code Section 385 as equity. The conversion of purported debt can have significant adverse income tax effects for the borrower and lender. Those regulations were withdrawn and we have been without regulations since then. The IRS has now issued new proposed regulations on the subject.

Below is a short overview of the new regulations and some observations. The proposed regulations are lengthy and complicated, so there will surely be a lot written about the as they are digested by the tax community…

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